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Aug 20

What Is Peer-to-Peer Lending?

Reading Time: 5 mins

Peer-to-peer lending (P2P) has grown in recent years. But what is it – and how can you both make money from investing in it, and borrow cash to fund projects?

As savings rates plummet to not-worth-it levels, putting your money into other things can help protect your future wealth growth. Peer-to-peer lending is a great alternative for some people – so we’ve put together a quick guide to help you decide if it’s an ideal option for you.

What is peer-to-peer lending?

Peer-to-peer lending explained

After the 2008 crisis, the banks were restricting their lending to businesses and created tighter regulations for loans. So, entrepreneurs needed to find a different way to get financial help. This is how P2P platforms started taking off. Peer-to-peer lending essentially means that people can loan money to other individuals and businesses without the intermediary – the bank. However, the risk is higher for investors if the borrower defaults on the loan. When using the bank as a middleman, the bank covers for any fold on the payment, whilst on peer-to-peer this service is not guaranteed. Nonetheless, because the risk is higher the rewards are also bigger. In P2P, people can get over 5% interest rate on their loans (in previous years, this was up to 12% with selected platforms like Blend Network).

To overcome the risk of borrowers defaulting on their loans, P2P platforms have introduced different diversification strategies. For example, Zopa breaks down a £1,000 loan into £10 chunks spreading it out across their marketplace of borrowers. This diminishes your risk and you’re still getting your high interest rates.

The disadvantages of P2P Lending

While the interest is a lot higher than normal ISAs or index funds, you cannot withdraw your money from the account until the term you agreed to has come to an end. If you decide to take out your money before the term ends, you might have to incur a withdrawal fee. This fee depends on the platform that you’re using. If you decide to withdraw your money early, you also need to ensure that the fees you’re being charged still leave you in a favourable position financially and you’re not losing money.

Your money also isn’t covered by the FSCS compensation scheme: if your platform goes bust, your investment is lost. If your borrower defaults, you may not get your money back. Like any investment, there’s a risk you’ll get back less than you put in – or lose it all. On the flip side, the return potential means that, for some, it’s worth this risk.

Peer to Peer Lending during Lockdown

Peer-to-peer lending remained surprisingly stable in lockdown

Peer-to peer-lending only started booming a little over 10 years ago in the UK. Being relatively new, it’s hard to predict the continuity and prosperity of certain P2P lending platforms long-term. In the past, like any new business, some of them have gone bust as quickly as they started. However, during this recession, the peer-to-peer lending business has been very resilient, with no platform having gone bankrupt. Withdrawal requests increased significantly in March peaking on March 16th, then returned to normal levels over the following weeks. There were £55 million worth of withdrawals since the start of the outbreak. Yet, stats show that 9 out of 10 investors continued to invest.

The way P2P lending platform have managed the crisis was mainly through temporarily cutting interest rates, holding new capital, and hitting pause on the secondary markets. Platforms like Ratesetter sent daily updates to its users to reassure the people who panic and demand their cash back. They have also cut their rate in half to avoid investors losing capital. The Funding Circle went a step further restricting the access of secondary markets. Assetz Capital has also temporarily cut down their interest rate. Their accounts went down from 5.75% to 4.10%, but they’re accepting new investments still and you can trade in the secondary market.

On the other hand, the most untouchable platform has been Zopa. They had the best performance during this recession, especially in the personal loans subsector. They are still offering 6% interest rates and welcoming new customers. They’ve limited the loan boat to just A and B grade borrowers for the duration of the crisis temporarily avoiding riskier options in the C to E markets, raising the interest rate charges for those borrowers.

Coming out of lockdown, businesses will again return to peer-to-peer lending to get back on their feet, which will increase the returns for investors. For a well-balanced cash flow portfolio, P2P lending is definitely a must-have investment.

Things to consider About Investing in P2P

P2P lending is as benevolent an investment type as you can get. You’re helping small businesses to succeed, create jobs, and contribute to the econoomy. Yes, you benefit too – but everyone (theoretically) wins in this scenario. Committing a small percentage of your income to P2P lending is one way to help independent business owners to succeed.

However, it’s not a full investment strategy by any means. As with any investment, you should diversify. That means putting your spare cash into several different types of investment. Split your money across a pension, an equities ISA, and P2P lending (as an example), to make sure you don’t risk all of your cash on one thing. Remember, too, that you need some form of easy access savings. We all know savings rates are rubbish at the moment – but you still need to have an emergency buffer that you can access at any time. Investing in P2P lending locks your money away – so you can’t access it in an emergency.

Peer to Peer lending platforms

There are a variety of platforms to choose from in this sector. All of them have different fees, types of accounts, interest rates, and minimum investment amounts. While on Ratesetter you can start with as little as £10 and earn interest daily, on other platforms like Zopa your minimum investment is £1,000 and the earnings are annual. Most platforms, however, offer similar interest rates and account lengths of up to 5 years. These are the main successfully operating platforms in the UK:

Before choosing a platform, research the terms of each. Some require longer tie-ins, while others may have minimum investments. A few have a damage fund to help recover some lost investments, while others don’t. Research well before you invest! And remember, if you’re ever unsure about how to invest your money, seek independent professional advice from a registered financial advisor.

Using P2P to Borrow for Your Own Projects

Peer-to-peer lending gives people starting up their business, or wanting to launch a new product, a great way to secure funding. It’s not always easy to get a high street bank loan, especially as a new (therefore unproven) company.

If you’ve used lockdown and furlough to start making plans for your new business, P2P lending could be an ideal funding route for you. Check out our guide to funding your startup to decide if it’s the best way for you to borrow capital to set up your business!

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